We’ve weighed the pros and cons of passive commercial real estate investing in Syndications versus investing in REITs, but what about another type of real estate — single family homes? To passively invest in single family homes (SFRs) is to purchase an SFR with the purposes of holding it as a rental property from a turnkey provider who handles every aspect of the transaction. To invest in a commercial real estate syndication — a partnership between a operator who handles every aspect of the transaction and the passive investor who funds a portion of the down payment and rehab costs — and share in the profits.
Since both strategies are passive, they’re equal in regard to control (or lack thereof). However, being two distinctive types of real estate, the benefits and drawbacks of each are different. So, in order to determine which passive investment strategy is better for you, let’s compare and contrast them based on three categories: time commitment, returns and risks.
1. Time Commitment
There is no such thing as a 100% passive investment. There are similar time commitments for both strategies: You must initially qualify the sponsor/turnkey provider, qualify their deals before investing and stay up-to-date on the progress of the deal after close.
There are also differences.
Because it is a one-unit residential house, understanding and evaluating an SFR is not that complicated. You likely have the education to acquire a passive SFR investment. On the other hand, apartments are a more complex asset class. Before becoming a passive investor, you’ll likely need to educate yourself on the apartment syndication process.
It’s easier to scale by passively investing in apartment syndications. After you’ve qualified the sponsor, it’s as simple as they send you a deal, and you decide whether to invest. For each SFR investment, you’ll select from a menu of deals. It can take months until you find one that meets your investment goals, at which point the process repeats itself.
Additionally, since you’re limited to the number of residential loans you can obtain usually around 10 or so, you’ll eventually have to either purchase SFRs with all cash or with creative financing, both of which take more time than traditional financing. For apartment syndications, you can usually invest any amount — although a minimum investment of about $50,000 is common — an unlimited number of times without having to worry about securing or qualify for financing. This reduces your ongoing time commitment and increases your ability to scale.
This is how many people start investing into real estate with single family homes including myself, but you don’t have to do that. You can skip this step and start building your passive income by investing into commercial real estate such as: apartments, hotels, storage units, etc.
In regard to returns, the two factors to address are cash flow and equity. Cash flow is the profit distributed to the passive investor on an ongoing basis, and equity is the profit captured at sale and/or refinance.
As a passive investor in a single family home, you have 100% ownership of the property, which means you receive 100% of the profits. Since an SFR has one rentable unit, the returns are more fragile. If you have one vacancy, you’re 100% vacant. If you have one maintenance issue or expensive turn, your cash flow for a few months to a few years can be wiped out.
After acquiring and owning a few single family home rentals, I can tell you that all my cash flow projections before purchasing them were all wrong as I incurred unexpected expenses that wiped out any gains I expected.As a passive apartment investor, you only have partial ownership of the property, which means you receive a smaller percentage of the profits. But, since apartments have hundreds of units, a few vacancies, evictions or maintenance issues have a lower impact on the cash flow. At the same time, you are typically offered a preferred return, which is a threshold return distributed to investors before the sponsor receives payment. A greater number of units combined with a preferred return results in more certainty as it relates to cash flow.
The value of SFRs is dependent not on the rents but on the market, which is out of your control. Sure, in an appreciating market, you could double the property value. But you could also get unlucky with a stagnating or depreciating market.
The value of an apartment is dependent on the revenue, not the market, which is in your — or technically, the sponsors’ — control. The sponsor can increase the rents through renovations and increase the revenue by offering certain amenities (i.e., coin-operated laundry, carports, storage lockers, etc.). Luck is removed and replaced with skill. If the sponsor executes the business plan and increases the revenue, the property value, and thus your investment, is increased.
You have 100% ownership as a passive investor in a single family home, which means you participate in 100% of the upside and 100% of the downside. You hold all of the risk. Since you sign on the loan, you are responsible for 100% of the debt. Default on a payment, and you are the one who is impacted.
Again, the SFR cash flow is more fragile due to having one rentable unit. However, this risk is reduced once you’ve scaled to a certain number of SFRs.
But having a passive portfolio of 100 SFRs is different than passively investing in a 100-unit apartment community. The single family homes are scattered across the market, which means you don’t benefit as much from economies of scale. Management and contractor (i.e., landscapers, maintenance people, etc.) fees are costlier. The benefit, however, is that you have 100% ownership of the 100 SFRs as opposed to partial ownership in the 100-unit apartment community, which means you’ll have a greater long-term upside potential.
Passively investing in commercial syndications is less risky because you aren’t signing on a loan. The risk is also reduced from day one because you are investing in multiple units right away as opposed to having to scale to hundreds of units. And with hundreds of units in one centralized location comes economies of scale, which means lower management and contractor costs.
Who is the Winner?
In my experience as many as other investors commercial syndications have a lower time commitment, more certain returns and less risk. SFRs have less scalability, more risk and fragile returns in the medium-term with a greater long-term upside potential.
End of the day, the best strategy comes down analyzing the pros and cons of each and determining which one aligns the best for your risk tolerance, time commitment and return goals.